Chapter 13

The New Deal

Price Fishback

1

The New Deal

After the largely evolutionary changes in the government’s role during the Progressive

Era and the wartime emergency expansion during World War I, government activity continued to

grow along its long-term path. While many of the temporary war-time programs were being

phased out, other programs continued to expand. Governments were building a rapidly

expanding network of roads and highways that could accommodate the diffusion of the

automobile and districts and states continued to add high schools. Meanwhile, lobbyists from a

variety of interest groups and reform movements were sowing the seeds for later expansions. In

many ways, however, the 1920s were the calm before the storm, as the Great Depression soon

encouraged drastic changes in the landscape of government and the economy.

Just prior to the Stock Market Crash of 1929, the economy turned downward. Despite

optimism after the crash that the economy would soon recover, the economy continued its

downward slide into the worst depression in American History. By 1933 real output in the U.S.

was 30 percent below its 1929 peak and prices had fallen dramatically. Unemployment rates

eventually peaked above 25 percent in 1933 but remained above 10 percent for the entire decade

of the 1930s. Ironically, given the shift toward more government involvement in the economy,

federal macroeconomic policies likely contributed significantly to the depth of the Depression.

As the Depression deepened, President Herbert Hoover, a strong Progressive in his own

right, experimented with a variety of new policies that called on the government to combat the

growing problems. His most prominent effort was the establishment of the Reconstruction

Finance Corporation (RFC). Modeled on the War Finance Corporation in World War I, the RFC

sought to resurrect the economy through massive loans to banks, railroads, industry, and

governments. Hoover’s actions met little success in counteracting the downward slide and the

1932 elections swept Franklin Delano Roosevelt and a large Democratic congressional majority

into office.

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The U.S. economy had always been resilient and rebounded from sharp downturns, but

after four years of a continued slide, this downturn seemed different and notions that market

economies could be self-correcting were increasingly dismissed. Problems could be found in

nearly every nook and cranny of the economy. State and local governments, which had long held

responsibility for providing aid to those in trouble, were overwhelmed. Citing a peacetime

emergency, the administration rolled up its sleeves and within the First Hundred Days of office

established a “New Deal” for America. Identify a problem and the Roosevelt administration

offered a program to solve it. The programs had laudable goals: raise farm incomes, raise

wages, help the unemployed, stimulate industrial output by raising prices, offer liquidity to

housing markets, provide insurance for bank deposits, build social overhead capital, and still

more. Yet, the many programs at times worked at cross-purposes. For example, programs

designed to raise farm prices by limiting acreage contributed to greater unemployment in the farm

sector and certainly made life more difficult for consumers of farm products. The New Deal

programs went through several transformations. In 1935 Supreme Court decisions declared

unconstitutional a key farm program and the agency that operated Roosevelt’s industrial policies.

In a “Second New Deal” the Roosevelt administration retooled the farm program in the name of

soil conservation and re-enacted the organized labor portion of the industrial policy. Further, the

federal government’s role in providing relief to the unemployed and indigent was revamped. The

federal government continued to provide temporary work relief through the Works Progress

Administration, while the Social Security Act of 1935 established the long term programs for old-

age pensions and state/federal administration of unemployment insurance and welfare policy.

During the 1930s the role of government, particularly the federal government’s, ratcheted

upward in ways unanticipated by the Progressives of the early 1900s. Several New Deal

emergency programs were temporary and were phased out during or after World War II. Some

were successful based on several standards of measurement. Others were failures best not

repeated. In the end the New Deal established a legacy of social insurance programs, regulations,

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and procedures that are largely still in place today. Many have served as the basis on which new

programs have been built.

MACROECONOMIC POLICY DURING THE 1930S

A leading aspect of economic thought developed during the 20th century was an explicit

role for federal government macroeconomic policy. In the Employment Act of 1946 the U.S.

Congress gave the federal government the explicit responsibility to use monetary and fiscal

policy to help smooth the path of economic growth, maintain full employment, and avoid

inflation. Our central bank, the Federal Reserve System, handles the reins of monetary policy

while Congress, subject to Presidential veto, determines fiscal policy through its decisions on

spending and taxation. The implicit use of fiscal and monetary policy stretches back to the early

days of the century and macroeconomic policy during the 1930s has long dominated the

discussions of the Great Depression. The formation of the Federal Reserve System in 1913

established a full-blown central bank armed with policy tools that could influence the money

supply.1 Meanwhile, the Keynesian ideas of using government spending and taxation to stimulate

the economy were being developed as the Depression progressed.

The Central Bank Policy as a Contributor to the Great Depression.

The Holy Grail among American economists is an explanation of the cause of the Great

Depression that is convincing to the profession at large. Numerous explanations have been

proposed. Some argued that the economies tend to be cyclical with both short term fluctuations

and long Kondratieff cycles, and at various times every 30 to 90 years, there is a downturn of

biblical proportions (Schumpeter 1939). Others emphasize a sharp decline in investment and

construction following the construction and investment booms of the 1920s (Field 1992, Gordon

1974). Still others emphasize a decline in consumption, particularly of durable goods, that might

have been fueled in part by the uncertainties in the stock market (Romer 1990, Temin 1976).

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Most scholars, however, agree that the monetary policies of the Federal Reserve contributed to

some degree to the decline in the early 1930s, although there is still disagreement about the

magnitude of the Fed’s actions and the reasons why Federal Reserve policy was misguided.2

Milton Friedman and Anna Schartz (1963) originated the argument that the Fed bears

significant responsibility for the tremendous drop in output between 1929 and 1933. Under the

Federal Reserve Act of 1913, the Federal Reserve was given the responsibility of creating an

“elastic” currency. Although the concept of an elastic currency was vague, most observers

thought that the Fed was expected to help solve liquidity crises during bank runs. By the 1920s

the Fed had two effective tools for influencing the money supply, the discount rate at which

member banks borrowed from the Fed to meet their reserve requirements and open market

operations. The open market operations involved the purchase or sale of existing bonds.

Reductions in the discount rate and purchases of bonds contributed to increases in the money

supply. Thus, if the Fed had focused on problems with bank failures and unemployment within

the U.S. economy, their optimal strategy was to lower the discount rate and purchase bonds.

Yet the Federal Reserve also had to pay attention to the gold supply in the United States.

The U.S. adhered to the international gold standard, which was essentially a promise that the

Federal Reserve and U.S. banks would pay out an ounce of gold for every $20.67 in Federal

Reserve notes received in international transactions. The Federal Reserve sought to make sure

that U.S. gold reserves were adequate to make this promise credible. If changes in the relative

attractiveness of the dollar led the U.S. supply of gold to fall below the appropriate level, the Fed

was expected to take actions to make the dollar more attractive. At the time the standard policies

in response to gold outflows included raising the discount rate and selling (or at least reducing

purchases) of existing bonds.

The Federal Reserve’s attempts to slow the speculative boom in stocks contributed to

slowing the money supply between 1928 and 1929. Over the next four years there were a series

of negative shocks to the money supply, including the stock market crash in 1929, banking crises

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in 1930-31, 1931, and 1932-3, and Britain’s abandonment of the gold standard in November

1931. Friedman and Schwartz argue that the Federal Reserve’s response to these crises was best

described as “too little, too late.” Had the Fed offset the early crises quickly with much larger

open market purchases of bonds and faster cuts in the discount rate, they could have limited the

damage and prevented the rapid decline in the money supply. The economy would have been in a

much better position when the next crises hit, or some of the later crises would have been

prevented or softened significantly. The Fed’s boldest move, an open market purchase of $1

billion in bonds in the spring of 1932, would have been extremely effective in 1930, but two

years later essentially served to close the drain after most of the water had already run out.3

Why was the Federal Reserve so recalcitrant? Friedman and Schwartz argued that the

Federal Reserve lacked strong leadership of the right kind. Benjamin Strong, a powerful

advocate for a focus on protecting the domestic economy as the head of the New York Federal

Reserve Bank, had died in 1928. Even though his replacements at the New York Fed argued for

expansive bond purchases in the early 1930s, they were overridden by the rest of the Fed policy

makers, who tended to hold the Austrian view that Fed interference would prolong the problems

(Friedman and Schwartz 1963, Rothbard 2000).

Not all agree that the Fed had changed directions with the death of Benjamin Strong.

David Wheelock (1992) compared the Federal Reserve’s responses to the downturns in the 1920s

to those in the early 1930s. In statistical analyses of Fed policy he found that the Fed seemed to

be responding to domestic and international changes in largely the same way in both the 1920s

and the 1930s. He argued that the Fed failed to recognize that the problems during the Great

Depression were so large that they required the Fed to take much greater action to save banks and

stimulate the money supply. For example, the Fed allowed thousands of banks to fail during the

1920s because they believed them to be weaker banks that normally would not survive in a

market economy. The banks failing in the early 1930s, having already survived through the

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1920s, were generally stronger, and the Fed failed to recognize that many were failing due to

extraordinary circumstances.

Some of the Fed’s actions might best be understood by examining its international role in

defending the gold standard. Barry Eichengreen (1992) argues that the Fed’s strong commitment

to the gold standard tied its hands. Even though the money supply and the economy was

continuing to decline, outflows of gold when Britain left the gold standard in 1931 and during the

banking crisis in March of 1933 led the Fed to raise the discount rate. Once the U.S. left the gold

standard in 1933, it was freer to focus on domestic policy and the money supply and the economy

began to recover. Eichengreen (1992) finds that this same pattern was repeated throughout the

world. In country after country, central banks that sought to maintain the gold standard saw their

domestic economies sink. As each left the gold standard, their economies rebounded. By

leaving the gold standard, the U.S. received a substantial flow of gold into the American

economy caused by our devaluation of the dollar to $35 per ounce of gold and by political

developments in Europe that stimulated the money supply (Eichengreen 1992, Temin and

Wigmore 1990).

In addition to leaving the gold standard, the Roosevelt administration sought to ease the

pressure on banks in March 1933 by declaring a national Bank Holiday. During a series of bank

runs between October 1932 and March 1933 30 states declared bank holidays, which took the

pressure off of the deposits in states where the banks were closed, but increased runs by

depositors in the states where banks remained open. Under the national Bank Holiday all banks

and thrift institutions were temporarily closed, auditors examined the banks. Banks declared

sound were soon reopened. Conservators were appointed to improve the positions of the

insolvent banks and the Reconstruction Finance Corporation was given the power to subscribe to

stock issues from the reorganized banks. These seals of approval conferred on the reopened

banks helped change expectations about the solvency of the bank system (Smiley 2002, 26-28,

74-5).

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With the benefit of hindsight, the appropriate choices for the Central Bank now seem

more obvious, although there are still debates about the effectiveness of different policies.

Recognize, however, that the Federal Reserve was less than 20 years old and its administrators

were relatively inexperienced as central bankers. Learning from the mistakes from other

countries with a longer history of central banking was of little use, because nearly every other

central bank in the world was making the same mistakes.

Yet, Friedman and Schwartz argued that the Fed still had more lessons to learn. In 1935

the Banking Act of 1935 reorganized the Federal Reserve System and also gave it direct

administrative control over the reserve requirements for their member banks. Under the

fractional reserve system member banks were required to hold a share of deposits with the Fed as

backing for their deposits. By 1935 the economy had been moving through two years of

recovery. The real GDP growth rate was very rapid, in large part because the economy was

starting from a base that was 36 percent below the level in 1929. The number unemployed had

dropped significantly, although they still composed over 15 percent of the labor force.4 Noting

that banks were holding large reserves above and beyond the reserve requirements, the Fed began

worrying about the possibility of inflation. If the banks started lending out their excess reserves,

the Fed worried that the rise in the money supply, which would be multiplied through successive

loans, would lead to rapid inflation that would halt the recovery. Feeling that the recovery was

far enough along, the Federal Reserve doubled reserve requirements in three steps between 1935

and 1937. The Fed had not recognized that the banks were holding so many excess reserves to

protect themselves against bank runs. Recent experience had given them little confidence that the

Fed would act as a lender of last resort. Therefore, the banks increased their reserves to make

sure that they kept roughly the same cushion. The policy contributed to a reduction in the money

supply, a spike in unemployment, and a decline in real GDP growth in 1937-38. 5

Federal Fiscal Policy: Spending and Taxation at the National Level

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During the severe worldwide problems of the Great Depression, John Maynard Keynes

developed his seminal theories on the impact of government spending and taxation on income

and wealth. Keynes actively discussed his ideas with his colleagues during the early 1930s and

they were published in The General Theory of Employment Interest and Money in 1935. The

theories of the classical economists suggested that periods of high unemployment would lead to

downward adjustments to wages in the labor markets and prices in product markets that would

naturally cause the economy to return to an equilibrium at full employment. Keynes argued that

wages were sometimes “sticky” in a downward direction and that long-term contracts between

workers and employers, union strength, and a host of factors might prevent wages from falling.

Similarly, product prices might not always adjust. As a result, the economy might settle into a

new long-term equilibrium where resources would not be fully employed. One solution to the

problem was for governments to stimulate the economy by increasing government spending or

reducing tax collections. These moves would lead to budget deficits that could move the

economy back toward a new equilibrium where all resources would be fully employed.

Under the New Deal the Roosevelt administration embarked on an ambitious spending

program, more than doubling the Hoover administration’s federal spending in real terms (1958$)

from an average of $7.3 billion in 1930-32 to an average of $15.7 billion in 1934-1939 (see

Figure 1). The rise was so large that it seems obvious that Roosevelt was following the

Keynesian prescriptions for a depressed economy. But closer study casts significant doubt on

that interpretation. Keynes published an open letter to Roosevelt in the New York Times in

December of 1933 suggesting that Roosevelt practice stimulative spending policies. They met in

1934 but most observers believe that Keynes had little impact on the President’s thinking (Barber

1996, 52, 83-4). Even though Keynes’ ideas were in circulation by 1933, the lag between

academic advances and their use in policy tends to involve decades. In fact, Keynes himself once

claimed: “Madmen in authority, who hear voices in the air, are distilling their frenzy from some

academic scribblers of a few years back.” Among Roosevelt’s advisers, there were several who

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also argued for using government programs as a stimulus but they followed a different logical

path for their arguments (Barber 1996).

Roosevelt was following a far more conservative path, because he, like Hoover, sought to

avoid leaving the federal budget too far out of balance. As a result, average federal tax

collections also more than doubled between 1930-32 and 1934-1939 from $4.7 billion to $11.8

billion. The Revenue Act of 1932 passed by the Hoover Administration had sharply raised rates

for the less than 10 percent of the households paying federal taxes during the 1930s. Individuals

earning between two and three thousand dollars saw their effective tax rates rise from 0.1 percent

to 2 percent in 1932. Those earning over $1 million experienced a rate increase from 23.1 to 57.1

percent. The Roosevelt administration could have opted to lower the rates, but only made slight

adjustments during the rest of the 1930s, lowering them some for those earning less than $10,000

and raising them some for those earning over $100,000.

As a result, the federal budget deficit was never very large relative to the economic

shortfalls during the 1930s. Writing in 1941, Alva Hansen, a major figure in aiding the diffusion

of Keynesian thought in the economics profession stated, “Despite the fairly good showing made

in the recovery up to 1937, the fact is that neither before nor since has the administration pursued

a really positive expansionist program…For the most part the federal government engaged in a

salvaging program and not in a program of positive expansion.” (quoted in Brown 1956, p. 866).

Figure 1 bears this out. It shows the federal budget deficit in billions of 1958 dollars from 1929

through 1941. After running surpluses in 1929 and 1930, the Hoover government ran budget

deficits of 4.7 billion and $3.5 billion in 1931 and 1932. The Roosevelt administration ran one

surplus in 1937 and deficits in other years ranging from $2 billion in 1933 to 7.5 billion in 1936.

The peaks under both administrations were probably not attempts to establish a Keynesian

stimulus package. In both 1931 and 1936 Congress passed large-scale payments to veterans over

the vetoes of Hoover and Roosevelt, and these composed the bulk of the budget deficit.

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As a share of GNP, these budget deficits pale in comparison to some periods during the

post-war era. Budget deficits during the 1930s never reached more than 3.9 percent of GNP in

any one year. This was true even though the GNP had fallen drastically. Based on this metric,

Ronald Reagan in the 1980s looks far more Keynesian than Roosevelt, as budget deficits reached

above 5 percent in some years during the Reagan era.

The ultimate goal of any stimulus program is to reach full employment. Figure 1 also

shows the difference between real GNP (in $1958) in each year and the 1929 full-employment

peak of $203.6 billion. If these were attempts at Keynesian stimulus to return to full

employment, the budget deficits were mere cupfuls of dollars that would have barely filled the

target bucket. Real GNP in 1933 was $62.1 billion below its 1929 level while the real budget

deficit was only $2 billion. In 1934 a $5 billion dollar deficit was matched with a GNP shortfall

of $49.3 billion; in 1935 the $4.5 billion dollar deficit was offsetting a $34.1 billion shortfall.

The figures look strongest in 1936 when a 7.5 billion deficit was matched with a $10.6 billion

GNP shortfall. Keynesians argue that budget deficits have multiplier effects. For these deficits to

be meaningful at returning to full employment, the multiplier effects would have had to have

been close to ten, when even the most ardent Keynesians find multipliers of only around two.

One of the Keynesian concepts was the balanced budget multiplier; a dollar increase in

government spending matched by a dollar increase in taxation would lead incomes to rise by a

dollar. Thus, we should look at government spending relative to the GNP shortfalls. Yet the real

government spending estimates over this 1933 to 1936 period range from $8.7 billion in 1933 to

$13.1 billion in 1934 and 1935. In the year of the veterans’ bonus, real spending peaked at $18.1

billion. These figures pale in comparison to the shortfall in national income.

The extent to which fiscal policy is stimulative involves more complex calculations than

the ones described here. For example, increases in income as people come closer to full

employment automatically lead to higher tax collections because of the progressive nature of the

tax rate system. This fiscal drag reduces the stimulative nature of spending. E. Cary Brown

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(1956) and Larry Peppers (1973) both performed thought experiments in which they assessed the

budgets of the 1930s while taking the fiscal drag and other issues into account. Both find that the

New Deal deficits were even less stimulative than the raw numbers shown here suggest. In fact,

Peppers argues that Hoover was following more stimulative fiscal policies than Roosevelt.

Any impact that the federal government deficits had in promoting recovery had to

compete with the contractionary changes in state and local government budgets after 1933. Prior

to 1933, state and local governments generally held nearly full responsibility for relief of the

indigent and the unemployed. By 1933 state and local governments were overwhelmed by these

and other responsibilities in the midst of a sharp decline in their revenues. A number were forced

to run short-term deficits in the early 1930s. Yet state constitutions generally require balanced

year-to-year budgets. To repay the budget shortfalls and also the debt issued during the early

1930s, state and local governments began raising taxes and establishing new taxes after 1933.

The problem was further exacerbated when the federal government dumped responsibility for

direct relief to “unemployables” back onto the state and local governments in 1935 after two

years of extensive spending. Thus, in the latter half of the 1930s, state and local governments

were often running small surpluses [See Brown 1956].

Not all taxes were designed to raise revenue. The Smoot-Hawley Tariff Act of 1930

raised taxes on imports substantially on top of an earlier rise in 1922 (Irwin 1998) in an attempt to

protect American manufacturers from competition from foreign imports. International trade was

a small enough percentage of the American economy at the time that most economists ascribe the

tariff a secondary role as a contributor to the Depression in the U.S., but it had far worse

implications at the international level. The Smoot-Hawley tariff was matched by a series of

protectionist measures by countries throughout the world. As each nation tried to protect its

home production interests through higher tariffs and restrictions on imports, world trade spiraled

downward. By 1933 the total imports for 75 countries had fallen to roughly one-third of the level

seen in 1929 (see Kindleberger, 1986, 170 and Atack and Passell 1994, 602).

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The Roosevelt administration contributed to a recovery in world trade by relaxing these

tariff barriers. The Reciprocal Trade Agreement (RTA) Act of 1934 freed the Roosevelt

administration to sign a series of tariff reduction agreements with key trading partners.

Agreements with Canada, several South American countries, Britain and key European trading

partners loosened the trade restrictions markedly. As a result, American imports rose from a 20-

year low in 1932-1933 to an all-time high by 1940.

THE RECONSTRUCTION FINANCE CORPORATION: THE TRANSITION AGENCY

As the Federal Reserve System acted too little too late in the early 1930s, the Hoover

Administration sought other ways to inject liquidity into the economy by forming the

Reconstruction Finance Corporation (RFC) in February 1932. The RFC was modeled after the

War Finance Corporation of World War I. Its first moves included making loans to 4,000 banks,

railroads, credit unions and mortgage loan companies to provide assets that would jumpstart

commercial lending. Among the most important programs was the provision of loans to troubled

banks to seek to provide them with enough liquidity to survive bank runs. Recent studies suggest

that these initial loans were not successful because the RFC loans were given first priority over

depositors and other lenders in situations where the bank failed. As a result, banks had to hold

the assets that they could sell most easily to insure repayment of the RFC loans. These assets

could not then be used to repay depositors when the bank failed. When the RFC began to accept

more risk by purchasing preferred stock in the troubled banks, it was more successful at staving

off bank failures (Mason 2001).6

The Roosevelt administration saw uses immediately for the RFC and gave the off-budget

corporation extraordinary leeway. The RFC retained control of a large supply of funds that could

be loaned out and had the authority to borrow still more funds without having to constantly return

to Congress for new appropriations. As the loans were repaid, the RFC continually had new

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funds to loan out again. The President and Congress quickly came to love the RFC because it

gave them so much flexibility. “By the mid-1930s, the RFC was making loans to banks, savings

banks, building and loan associations, credit unions, railroads, industrial banks, farmers,

commercial businesses, federal land banks, production credit associations, farm cooperative,

mortgage loan companies, insurance companies, school districts, and livestock credit corporations

(Olson 1988, 43-4; see also Jones 1939, 1951).” Perhaps even more importantly, the RFC

became the banker to many of the New Deal programs, providing loans and/or startup working

capital to the Public Works Administration (PWA), Home Owners’ Loan Corporation (HOLC),

Farm Credit Administration (FCA), the Federal Housing Administration (FHA), Rural

Electrification Administration (REA), and the Works Progress Administration (Olson 1988).

It is clear that the RFC was central to the operation of Roosevelt’s New Deal. Its record

at stimulating recovery is somewhat mixed. Hoover’s original goal for the RFC was to expand

commercial credit to 1929 levels, but this probably unobtainable short-term goal was not met

until the end of the 1930s. As one example, RFC loans to railroads and industries did contribute

to delaying bankruptcies for businesses and railroads. Yet the delay of bankruptcies may have

been a mixed blessing. The delays gave financial institutions more time to reduce their holdings

of railroad bonds. However, there is evidence that the delays may have retarded needed

maintenance and capital expenditures. When railroads were in trouble they tended to cut back on

maintenance of their rolling stock and rails and other capital equipment. One advantage of

bankruptcies is that they forced railroads that could be viable again to make the proper

investments in order to attract the necessary capital for reorganization. A recent study suggests

that railroads that received RFC support continued to delay these types of expenditures when

compared with the railroads that went through bankruptcy proceedings (Mason and Schiffman

2004).

The RFC was designed to be a temporary emergency agency and by 1939 there were

extensive discussions about winding it down. The Nazi invasion of France in 1940 led to a

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transformation of the RFC into a wartime agency that more closely resembled its ancestor the

War Finance Corporation. The RFC established a series of companies to stockpile materials and

products considered strategic for national defense, to finance new defense plant construction, to

provide loans for housing construction for defense workers, and made a wide variety of loans to

businesses in the war effort. At the end of the war the RFC was wound down (Olson 1988, Jones

1988).

EMERGENCY RELIEF AND PUBLIC WORKS PROGRAMS

Federal spending during the 1930s was less about macroeconomic stimulus in the modern

sense of the word and more about solving the harsh problems that had arisen during the

Depression. One of the central problems was determining how to aid the huge numbers of

unemployed and discouraged workers. Prior to the Depression, the federal government had

assumed virtually no responsibility for the provision of relief payments to low-income people and

the unemployed.7 Unemployment and poverty were seen as local problems best dealt with by

state and local governments and charities. As the local public and private relief structures became

overwhelmed by unprecedented levels of unemployment in the early 1930s, views toward the

federal role shifted. The Hoover Administration worked within the existing framework by

authorizing the Reconstruction Finance Corporation in 1932 to loan up to $300 million to cities to

provide relief. Originally, these loans were meant to be repaid at three percent interest through

reductions in future highway apportionments, but the RFC was allowed to write them off in 1938

(Jones 1951, 178).

By the time Roosevelt took office in March 1933, unemployment rates had surged well

past 20 percent. Arguing that the Great Depression was a national peacetime emergency, the

federal government temporarily took over the lion’s share of the responsibility for relief. During

the First Hundred Days the Roosevelt Administration established the Federal Emergency Relief

Administration (FERA).8 The FERA distributed federal monies to the states, which in turn,

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distributed the monies to local areas, which administered the payments to households. The FERA

program offered either “direct” relief payments (with no work requirement) or “work” relief that

required a family member to work for the funds. The amounts paid were determined by a

“budget-deficit” principle. Local administrators compared the household’s income to a

hypothetical budget for a family that size and the maximum amount of relief would be

determined by this deficit. The actual payments often fell short of the maximum when relief

officials, faced with large case loads and limited funds, cut payments to provide relief for more

families.

By November 1933, the administration was wary about the still large number of

unemployed coupled with anticipation of a harsh winter. As a short-term fix, the Civil Works

Administration (CWA) was established to immediately put people to work on public jobs,

ranging from “make-work” activities, to maintenance jobs like raking leaves to the building of

roads and schools. By December 1933 the CWA employed 3.6 million people. Eligibility for

CWA employment was based on the budget-deficit principle, but the CWA wage payments were

not specifically tied to the size of the household deficit. It was closed down in March 1934 and

most of those employed were eventually transferred to FERA projects. Between July 1933 and

July 1935, the FERA and the CWA distributed roughly $3.5 billion in relief to families

throughout the United States.9

In mid-1935 the Roosevelt administration redesigned the federal government’s role in

providing relief. The federal government continued to provide work relief for the unemployed

who were “employable” through the Works Progress Administration (WPA), but returned much

of the responsibility for direct relief of “unemployables” to state and local governments.10

Applicants for aid were still certified by state and local officials, who continued to consider a

family’s budget-deficit when assessing its need for relief employment (Howard 1943, 380-403).

The federal WPA then hired people from the certification rolls and paid them a wage for a

restricted number of hours each month. Dissatisfied with its lack of control over work relief

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under the FERA, the WPA was administered more centrally by the federal government. Yet the

WPA, like its FERA predecessor, faced a mixture of pressures as administrators decided how to

distribute spending across the U.S. State and local governments lobbied for funds and federal

administrators appear to have paid attention to local economic distress and political necessities

(see Howard 1943, Fleck 1999a, 1999b, and 2001a, Fishback, Kantor, and Wallis 2003). All of

these emergency relief programs were seen as temporary by the Roosevelt Administration. Even

though some members of the administration wished to make them a permanent feature of the

economy, the WPA was phased out by the end of 1942.

The relief grants were an unusual mixture of transfer payments, work, and the building of

public projects. They were more closely associated with the workhouses of the past than to our

modern welfare state, although on a dramatically larger scale. In 1933 the administration could

have just relied on making direct relief payments without a work requirement. At that time,

however, the vast majority of Americans considered collecting government payments to be a

badge of shame. The preDepression attitudes that the poor (without disability) were responsible

for their own fate still held sway even as it became obvious that many hardworking people had

lost their jobs. One of the harshest outcomes of the Depression was the loss of confidence among

the populace that it was not enough to work hard to maintain a comfortable life. Long after the

Depression ended, this loss of confidence continued to influence the choices and attitudes toward

risk of the generations who lived through the era. The trade of work for relief payments was

considered less shameful, although even then a number of people were hesitant to accept the

government’s largesse. Harry Hopkins, the head of the FERA, CWA, and later the WPA,

preferred work relief, which “provided a man with something to do, put money in his pocket, and

kept his self-respect (Adams, 1977, 53).”

In the administration’s view the work relief programs were not revolutionary. They were

explicitly designed so as not to go beyond the public sector into the private sector. The projects

were traditional government projects, building and maintaining public buildings, schools, parks,

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roads, sanitation facilities, etc. Production of manufactured goods, creations of stores, and other

private sector activities were off limits. Further, the work relief pay was designed to be below

market wage rates to encourage workers to seek private employment. To combat fears that

private jobs would end quickly, the WPA assured people that they would be accepted back on

work relief if they lost their private job. Even so, a significant percentage of workers stayed on

work relief jobs for periods as long as a year and in some cases several years (Margo 1993,

1991).

As an alternative to work relief, the federal government (and state and local governments)

might have used the work relief funds to fund public projects in the usual way, either directly hire

employees at market wages or contract with construction firms who hired their workers in the

private market. Hopkins and his aides appeared to have rejected this alternative for several

reasons. First, they wanted to provide relief as quickly as possible to large number of struggling

households.11 Had the work relief funds been used instead to fund public projects in the usual

way, the same budget would have directly helped fewer people and built fewer projects. Second,

Roosevelt saw the work relief as temporary emergency funding. All the bills authorizing the

funds had “emergency” in their titles and these programs all ended when the Depression was

over. Further, the people on work relief were still considered unemployed in the official statistics

until they obtained private jobs. Even though Roosevelt occasionally delighted in tweaking

conservative big businessmen, he was sensitive to the traditional boundaries between private and

public employment. He resisted many efforts by more socialistic advisors to see work relief as a

permanent institution to solve problems with unemployment. Instead, he proffered the public

assistance and social insurance mechanisms established under the Social Security Act as his long-

term legacy.

The public works grants included expenditures by the Public Works Administration

(PWA), Public Buildings Administration (PBA), the Public Roads Administration (PRA), and the

Tennessee Valley Authority (TVA). The PWA was established under the National Industrial

18

Recovery Act of 1933, while the PBA and PRA were rearrangements of prior federal agencies

that had offered grants to states and cities to build roads and federal buildings outside

Washington, D.C. These grants were also used largely to employ workers, but the focus was less

on hiring the unemployed and more on building large-scale projects like dams, roads, schools,

sanitation facilities, and other forms of civil infrastructure.12 Consequently, the planning stages

on the projects were longer and the labor policies were more like nonDepression norms. Public

works projects paid substantially better wages than the relief projects, were freer to hire a broader

class of skilled workers, and were required to hire only a proportion of people from the relief rolls

(Clarke 1996, 62-68; Schlesinger 1958, 263-96). By the end of the 1930s, the PWA, WPA,

PRA, and PBA had been rolled into the Federal Works Agency (FWA). In 1942, the PWA and

WPA emergency programs had been terminated and the PBA and PRA duties were distributed to

new agencies.

How successful were the public works and relief programs at achieving their goals? On

their face they were wildly successful. The relief and public works programs marshaled

resources that put millions of people to work during the worst and longest depression in

American history. The WPA records at the National Archives are filled with box after box of

personal letters to Roosevelt and Harry Hopkins thanking them for helping their families survive

and get back on their feet. Many of the roads, buildings, post offices, and public works built by

the relief and public works projects in every county in America are still in place or renovated

versions of the original projects bear their stamp.

On a more cynical level, the programs succeeded by helping Roosevelt and Democratic

congressmen to remain in office. In 1938 WPA administrator Harry Hopkins allegedly declared

to friends that “we shall tax and tax and spend and spend and elect and elect” (McJimsey, 1987,

p. 124). Hopkins claimed that he had never made such a statement, but plenty of contemporaries

considered it to be the underlying truth. Millions of Americans could claim that the Roosevelt

19

administration had provide them with funds, a work relief job, or in-kind benefits during their

time of need, a fact that was easily remembered on election day.

There is another counterfactual standard against which these projects should be

measured. How much better did the local economies perform in response to work relief and

public works projects than they would have had the projects not been established? This is a

more difficult question to answer because it involves trying to construct a hypothetical history of

the era. It is a relevant question, however, when trying to assess the true impact of the projects

and whether such projects might be effective in the future. The impact of public works and relief

spending might have been mitigated by several factors. There was likely to be some fiscal drag

to the extent that the public works and relief spending led to higher incomes that generated more

federal income taxes and greater consumption of goods on which excise taxes were charged.

There is also the potential for crowding out of local activities. For example, local governments

might have used federal funds to build projects that they had already planned to build in the near

future. To obtain federal funds, state and/or local authorities often had to propose projects for

federal funding. Thus, the New Deal funds might have moved the projects forward by one or two

years as opposed to creating something that would never have been built. To some extent the

public works and work relief opportunities might have forced private companies to pay higher

wages to attract workers to new opportunities, which in turn would have retarded private

employment. Certainly, there were complaints by private employers to the WPA that this was

happening. Given the extremely high levels of unemployment, it might seem like the federal

projects would have just soaked up the unemployed and thus such “crowding out” of private

activity would not have been great. This is an empirical question that scholars are just now

beginning to answer.

Over the past two decades, a number of economists have used the geographic variation in

New Deal spending to measure the effect of the New Deal programs. The results still tell a

relatively optimistic story for public works and relief programs, although there may have been

20

some crowding out of private activity. A series of labor market studies offer a mixed view of the

success of relief programs. Studies of cross-sectional data, that provide a snapshot of the country

in a single year, suggest that areas with higher relief employment did not crowd out private

employment (Wallis and Benjamin 1981 and Fleck 1999b). However, studies using panel data,

that allow the scholars to capture variation both across geographic areas and over time, do find

some effects on private employment. A study of state averages suggests that for every relief job

created the private sector shed half of a private job; therefore, the net gain was half of a job

(Wallis and Benjamin 1987). An alternative study of cities during the 1930s finds that a typical

increase in relief jobs and an increase in the earnings on relief jobs might have combined to

increase private earnings by about 10 percent, which in turn might have cut the private quantity

demanded for private employment by as much as 10 percent (Newman, Fishback, and Kantor

2003).

The relief jobs may have helped workers in ways that, oddly enough, caused the official

measures of unemployment to rise. High unemployment rates often discourage workers from

seeking work. These discouraged workers are not considered unemployed under standard

definitions of unemployment, which require that someone be actively seeking work to be defined

as unemployed. Meanwhile during the 1930s relief workers were treated as unemployed in the

official statistics (Darby 1976). As a result when a relief job became available and was filled by a

discouraged worker, the number of unemployed in the official statistics would have risen by one.

In a study of county-level unemployment statistics for 1937 and 1940, Robert Fleck (1999b)

found that at the margin the creation of an additional relief job might well have been associated

with a one person increase in measured unemployment. Hence we see the odd effect that the

creation of an additional relief job could make the official unemployment statistics look worse.

A series of studies that are just being finished suggest that the impact of public works and

relief programs extended well beyond the labor market. An added dollar of public works and

relief spending in a U.S. county was associated with an increase in retail sales of roughly 40 to 50

21

cents. Given typical ratios of retail sales to income, this suggests that incomes in the county grew

roughly 85 cents at the mean when a dollar was added to public works and relief spending

(Fishback, Horrace, and Kantor 2004). Counties with greater great public works and relief

spending appeared to be more attractive to workers, as these counties experienced more in-

migration during the 1930s (Fishback, Horrace, and Kantor forthcoming).

By putting resources into the hands of struggling families and by building public works

that contributed to better public health, the relief and public works programs also may have

staved off a potential rise in infant mortality rates during the 1930s. Public health improvements

in the early 1900s had led to sharp declines in infant mortality through the early 1930s, but in the

heart of the Depression the infant mortality decline stalled temporarily. Studies of the experience

of black and white infants throughout the South and a panel of cities across the entire United

States suggest that the relief and public works programs contributed to lower infant mortality.

The city panel study finds that an infant life was saved with an expenditure of between $1 and $9

million dollars on relief in year 2000 dollars. This is approximately the value of life found in

labor market studies and is a substantially smaller cost than the cost of many modern safety

programs. The true cost of saving an infant life was probably smaller because the relief programs

were targeted at people of all ages and reducing infant mortality was only one of many goals of

the programs. Taking into consideration that only 1.5 percent of the people receiving relief aid

were infants, the expenditure per infant saved might have been more like $15,000 to $135,000 in

modern dollars (Fishback, Haines, and Kantor 2000, 2003).

THE FARM PROGRAMS

The dire situation for farmers in some ways may have been worse than in cities and

industries. An expansion of farms during World War I had followed a “Golden Era” of farm

prices in the early 1900s. As the Europeans recovered from the War in the early 1920s, demand

22

for American farm products declined, and the farm sector went through a difficult shakeout in the

early 1920s. After a decade of troubles farmers were hit still harder by the Great Depression.

As noted by Werner Troesken, farmers since the Gilded Age had long been protesting

their plight and seeking ways to limit output and raise prices. Large number of American

farmers and the competition from farmers abroad had combined to prevent the farmers from

successfully combining forces to limit output. By the 1920s, they had begun pressing the federal

government to limit production. In both 1927 and 1928 Congress passed versions of the

McNary-Haugen bill designed to raise farm prices without supply controls, but each was were

vetoed by the President. In 1929, the federal government began experimenting in a small way

with a program in which the Federal Farm Board purchased output from producers who limited

their output (Libecap 1998, 188-9). The Roosevelt administration responded to farmers’ pleas

during the First Hundred Days by establishing a series of measures that became the basis for our

modern farm programs.13

The goal was to limit supply and thus raise the farm/nonfarm ratio of prices to levels seen

during the Golden Era just prior to World War I. The centerpiece of the New Deal program was

the rental and benefit program administered by the Agricultural Adjustment Administration

(AAA). For a wide variety of farm products the AAA offered production agreements to farmers

that paid them to take land out of production. The funds for the program came from a tax on farm

output at the location where it was first processed, e.g., at the cotton gin for cotton.14 Farmers

were not required to accept the agreements, but the AAA set attractive terms and actively

marketed the programs through county agents and local boards of farmers. In the tobacco and

cotton programs federal decision-makers added a degree of coercion to the system by levying

heavy taxes on any production beyond designated limits.15 As a result, the sign-up rates ranged

between 70 and 95 percent for most types of crops. In 1935 the AAA program was declared

unconstitutional in the United States v. Butler on grounds that the processing tax used to finance

the AAA was unconstitutional. Farm interests who had warmed to the AAA pressed the

23

Roosevelt Administration to re-enact a similar program that would overcome the constitutional

objections. Soon thereafter, a new AAA was established that made payments to curtail land use,

adjust production, and conserve the soil under the Soil Conservation and Domestic Allotment

Act.

Many farmers also benefited from a wide range of loan programs. The Commodity

Credit Corporation (CCC) loaned funds to farmers for crops in storage with terms that

contributed to keeping prices high. When repayment time came, if crop prices exceeded the

target level, the farmer would sell the crop on the market and repay the government loan. If crop

prices were below the target, the farmer gave the crop to the government as payment on the loan.

From the beginning the CCC has set the target prices above market prices, so the CCC program

has operated as a price support program.

Farmers had long lobbied for federal intervention to provide cheaper and more adequate

sources of credit. With the National Farm Loan Act in 1916 and the establishment of Federal

Intermediate Credit Banks in 1923, the federal government had developed a farm credit system

with two types of land banks that aided in mortgage lending and a Federal Intermediate Credit

Bank that would purchase 9-month to 3-year bank loans, which freed up more funds for the banks

to expand lending for seed and provisions and other short term needs. By 1932 the land banks

held about one-seventh of the total farm-mortgage debt outstanding, although the joint-stock land

banks were liquidating because they had never generated sufficient capital to operate profitably.

The intermediate credit banks had not succeeded in generating amount of short-term credit

desired by farmers. As the Hoover administration ended, the land bank system expanded its

lending power. However, the true boom in farm lending resulted when theFarm Credit

Administration (FCA) was created in 1933 to revamp and administer the entire farm credit

system. Within 2 years the FCA programs had loaned out more than had been loaned in the prior

16 years. Consequently, the federal government was involved in more than half of farm

mortgages by the mid-1930s.16

24

The AAA and most loan programs were primarily oriented toward large farmers, but also

distributed smaller amounts of funds in programs designed to eliminate areas of persistent rural

poverty. The original FERA legislation called for aid to low-income farmers in the form of relief,

the Resettlement Administration moved some farmers to better land, and loans and grants from

other programs were provided to aid small family farms. These farm programs were later

transferred to the Farm Security Administration when it was formed in 1937.17 1 See the chapter on Financial systems by Richard Sylla in this volume.2 See Cole and Ohanian 1999 and Bordo, Erceg, and Evans (2000) for assessments of the impact of monetary policy shocks, fiscal policy shocks, and technology shocks as determinants of the path of macroeconomic activity. Their models predict the drop in income from 1929 to 1933 well but predict a much more rapid recovery than actually occurred. For recent efforts to explain the slow recovery, see Cole and Ohanian (2001), Harrison and Weder (2003), and Romer (1992).3 There is a huge literature on the causes of the Depression and not all agree with Friedman and Schwartz’ assessment of the Fed’s role. See Friedman and Schwartz (1963), Wheelock (1991), Temin (1976, 1989), Gordon (1974), Romer (1992), Rothbard (1962), Eichengreen (1992), Cole and Ohanian (1999), Bordo, Erceg, and Evans (2000). Atack and Passell (1994, 583-624) and Smiley (2002) offer a highly readable summary of the debates that strongly influenced the description here. 4 The unemployment rate was still well above 10 percent even if people working on relief projects are considered employed (Darby 1976).5 For a view that puts less emphasis on the Fed’s role, see Romer (1992).6 A number of scholars have suggested that the RFC contributed to greater insolvency by publishing the list of banks receiving loans after July 1932. Depositors might have seen these announcements as a signal that the banks were having problems and thus begun demanding their cash. Mason (2001) suggests that better measurement of when banks were revealed to have received RFC loans leads to results that do not support the announcement effect. 7 The federal government had established programs for disability payments to military veterans, workers’ compensation for federal employees, and retirement pensions for federal workers. See the chapter on the federal bureaucracy in this volume. 8Another New Deal relief program was the popular Civilian Conservation Corps (CCC), which provided short-term jobs to youths who moved to camps where they worked to conserve natural resources and returned a portion of earnings to their families.9 The program was phased out after July 1935 and the final expenditures were undertaken in March of 1937.10 After 1935 the federal government was not completely absent from providing direct relief to “unemployables,” as the Social Security Act of 1935 introduced joint state-federal versions of some earlier state programs, such as old-age assistance, aid to dependent children (replacing mothers’ pensions), and aid to the blind. Beginning in 1936, federal grants-in-aid became available on a matching basis to states administering approved plans under the Social Security Act. By the end of 1938, all but 8 states were receiving federal grants. The shift in focus of the federal relief efforts and the eventual reductions in federal emergency work relief programs caused the federal share to slowly decline to 57 percent by 1940.11 In fact, Hopkins succeeded in obtaining a substantially larger share of the total public works and relief budgets in part because he pleased Roosevelt by helping so many people much more quickly than Harold Ickes had with the Public Works Administration (PWA) monies (Schlesinger 1958, 283-96).12The WPA and FERA also built some large projects, as chief administrator Harry Hopkins often broke larger projects into smaller subprojects so that the work relief programs could claim more funds in the battles for resources.

25

The chapter on farm programs by Randy Rucker and E.C. Pasour later in the book deals

with the long-term effects of the farm programs. Observers of the short term impact in mid-

1930s were unsure whether the AAA payments to take land out of production were effective in

raising prices. Several studies suggest that farmers took the lowest quality land out of

production first and then found ways to raise the productivity on other acreage by using more

fertilizers and adopting new technologies (like tractors) as labor-saving devices (Libecap 1998,

footnotes on 193). Efforts to determine the AAA’s impact have been confounded because a

series of major climatic disasters, including droughts in some areas, floods in others, and the Dust

Bowl, that coincided with the AAA’s introduction and also contributed to drops in production and

higher prices.

Given that the programs were voluntary, the AAA likely benefited the farmers who

accepted the production agreements. However, the AAA might well have had an adverse effect

on the incomes of farm laborers, tenants, and sharecroppers. The program was strongly oriented

toward larger farms. Although sharecroppers and tenants were supposed to be eligible for AAA

payments, there is evidence that they did not receive their full share and that some were demoted

to wage laborers (Whatley 1983, Biles 1994, 39-43; Saloutos 1974). Further, AAA payments

required that the farmer remove land from production, likely causing the demand for farm labor

to fall, and leading to lower incomes for farm workers (Alston 1981). Recent studies of the

impact of the AAA grants on retail sales growth and on net migration at the county level during

the 1930s suggest that the gains to recipients of the grants were offset by losses to farm workers,

13 For a long-term view of the farm programs see the chapter by Rucker and Pasour in this book.14 The AAA hog and cotton programs to curtail production generated enormous controversy in 1933. To raise prices by cutting the amount of pork and cotton available for markets, the program required farmers to destroy 6 million pigs and plow under roughly 10 million acres of cotton. An enormous outcry arose although most of pigs were purchased by the Federal Surplus Relief Corporation and distributed to households on relief (Chandler 1970, 218).15 The taxes were imposed under the Bankhead Cotton Control Act for cotton and the Kerr-Smith Tobacco Control Act. See Nourse et. al., 1937, pp. 39-40, 96-102.16The paragraph is based on Halcrow 1953, 342-3.17 For more discussion of this program, see Alston and Ferrie (1999).

26

croppers, and tenants. Greater AAA payments did not lead to faster retail sales growth during the

1930s and areas with more AAA spending tended to experience more net out-migration than

other parts of the country (Fishback, Horrace, and Kantor 2003, 2004). In the South, where

observers felt the impact on low-income farmers was greatest, a recent study found that areas

with higher AAA spending were associated with higher infant mortality for both black and white

families. The association was stronger for black families than for white families (Fishback,

Haines, and Kantor 2001).

On the positive side the AAA helped prevent recurrences of the Dust Bowl of the 1930s,

in which high winds combined with drought and soil erosion to create enormous dust clouds that

blew through areas of Kansas, Colorado, Oklahoma, and Texas. Zeynep Hansen and Gary

Libecap (2004) find inadequate efforts to prevent soil erosion by the large numbers of small

farmers who had first settled the area under Homestead rules helped create the problem. Each of

the small farmers had little incentive to use methods to prevent soil erosion for two reasons. Such

efforts cut the amount of their production below a level that would allow them to farm profitably,

while the benefits of their efforts would have accrued to their neighbors and not to them. The

AAA, particularly the reformed version after 1935, encouraged the development of large farms

and required farmers receiving benefits to use techniques that cut soil erosion. One sign that

these changes were effective was that the same climactic conditions of strong winds and terrible

droughts hit the region again in the 1970s, but no Dust Bowl developed.

THE NATIONAL RECOVERY ADMINISTRATION: A MISGUIDED EXPERIMENT.

Just as they offered programs to reorganize the farm sector, Roosevelt’s advisors sought

to develop new institutions that would revive the industrial sector. Some saw the problem as lack

of supply caused by “destructive” competition that had driven prices lower, driving many firms

out of business, and reducing incentives to produce for the surviving firms. Coal companies,

farmers, and other troubled sectors in the 1920s had lobbied Congress for protections from such

27

competition during the 1920s. Meanwhile, the Roosevelt administration needed solutions for the

demand-side problems that continued to haunt the economy. After all, higher prices meant that

consumers would buy less. To counteract the price effect and stimulate purchasing, the

Roosevelt administration followed in the footsteps of the Hoover administration and sought ways

to keep wages high so that workers and consumers would have higher incomes. Realizing that

high wages might contribute to unemployment, the administration’s goal was to spread the work

by reducing hours worked per person. It was hoped that less exhausted workers would also raise

their hourly productivity, so that monthly earnings would not be reduced much.

This logic was the basis for the National Industrial Recovery Act (NIRA) of 1933. The

Act established a National Recovery Administration (NRA) to foster the development of “fair”

codes of competition in the various industries. Industrialists, workers, and consumers in each

industry met to establish rules for minimum prices, quality standards, and trade practices. The

workers were to be protected by minimum wages, hours limits, and rules related to working

conditions. Section 7a of the NIRA established standard language for the codes that gave

workers the right to bargain collectively through the agent of their choice. Once the code was

approved by the NRA the codes were to be binding to all firms in the industry, even those not

involved in the code writing process (Bellush 1975) .

It is quite clear in hindsight that the NRA was a disastrous policy. U.S. law had always

banned cartels and price-fixing agreements in restraint of trade. Suddenly, the federal

government was giving industry leaders antitrust exemptions and carte blanche to meet and

establish the basis for competition. Effective cartels require an enforcer because in the long run

cartel arrangements tend to fall apart as each firm has incentive to raise output and find ways to

break their agreements by lowering prices and/or improving quality. To put it bluntly, the federal

government had become the enforcer of cartel agreements in the majority of industries in

America. Adam Smith’s observation that “people of the same trade seldom meet together but the

conversation ends in a conspiracy against the public, or in some diversion to raise prices” seems

28

to have held true for many of the NRA code negotiations. The codes in quite a few sectors were

largely written by the leaders of trade associations in each industry with some influence by

consumers, as relatively few industries had a strong union presence. Many small firms

complained that the codes favored the large firms that were so prominent in writing them. Cartel

agreements do raise prices, but do so by limiting output. Wholesale prices jumped 23 percent in

2 years although consumer prices were much slower to rise, while industrial production was still

slow to recover.

The Roosevelt administration did have the goal that workers in the industries should

share in the economic profits generated by the codes. However, it is unclear that their wages

rose enough to overcome the higher industrial prices they would pay. Even with the goal of job

sharing engendered by hours limits, the NRA was just as likely (if not more) to contribute to

unemployment as solve it. Given that the Roosevelt administration tried so many policies

simultaneously, it is difficult to isolate the impact of the NRA. However, recent studies that

perform policy simulations with and without the NRA suggest that the NRA might well have

substantially slowed the recovery from the depths of the Depression (Cole and Ohanian 2001).

Even the businessmen who anticipated benefiting the most from the NRA restrictions

were not uniformly satisfied. In industries where there was greater diversity among the

participants, the process of writing the codes was often fraught with controversy, and many firms

considered the codes illegitimate and thus felt free to violate them. Firms signaled that they were

following the codes by displaying the Blue Eagle symbol of the NRA, but town gossip suggested

that a number of violators were displaying the symbol just as prominently. The Supreme Court

struck down the NRA as unconstitutional in the Schechter Poultry Case in 1935. Unlike the

AAA, there was little support for re-enacting the NRA from many quarters and the Roosevelt

administration let it die (Alexander, 1997; Alexander and Libecap 2000).

29

THE GEOGRAPHIC DISTRIBUTION OF FEDERAL FUNDS: PROMOTING RELIEF,

RECOVER, AND REFORM, OR POLITICS AS USUAL?

From the beginning the New Deal was controversial. In a famous Fireside Chat,

Roosevelt proclaimed that the New Deal would promote “Relief, Recovery, and Reform.”

Conservatives, critics and big businessmen charged the New Dealers with the more cynical

purpose of using government programs to build patronage and to “buy” voters to ensure the

continuation of the Democrat’s hegemony over the federal government. Over the past 35 years

scholars have been examining these claims by closely examining the geographic distribution of

New Deal funds. The range of New Deal spending per person across the states is striking,

ranging from highs for the decade of nearly $900 per person in the mountain west to lows of

roughly $100 per person in some southern regions. The U.S. is an economically diverse country

and there was substantial variation in the extent of the downturn across areas, so we might expect

the spending figures to vary. Among the patterns that drew attention was the relatively small

amounts received by southern states, even though southern per capita incomes were the lowest in

the nation and some southern states experienced among the worst of the downturns (Arrington

1970, Reading 1973).

Many modern programs have explicit formulas that determine the distribution of

spending through matching grants and specific counts. The inner workings of the emergency

New Deal programs are more difficult to fathom. Explicit formulas for matching funds written

into the FERA legislation were largely deemed unworkable after the first three months. Senate

testimony from FERA administrators on the distribution of funds offers a long list of factors that

were considered but little guidance on the weights each factor was given. Similarly, the WPA

matching requirements were routinely ignored and the shares of funds provided by state and local

governments varied widely (See Howard 1943, Edward Williams 1968), U.S. Senate 1991,

Couch and Shughart 1998, Wallis 1984, 1991).

30

Therefore, scholars of the New Deal have turned to statistical analysis of the geographic

patterns. More than thirty years of study suggest that the funds were distributed in response to a

complex mix of factors, although there is not full agreement on how much weight to give to each

factor. The rhetoric of the Roosevelt administration suggested that they were seeking to promote

Recovery, Relief, and Reform. Many studies, but not all, find evidence that the Roosevelt

administration promoted recovery and relief by spending more in areas with higher

unemployment and in areas where the economic downturn from 1929 to 1933 was more

pronounced. Relatively few find signs of reform or redistribution of income as areas with more

long-term poverty tended not to receive extra funds. Most programs required that state and local

governments develop and help fund projects to obtain federal grants. Some areas received

substantially less funding where leaders were leery of possible strings attached to New Deal

largesse or because they did not press as aggressively for funding. Areas with more federally-

owned land tended to receive more funds, as the administration sought to enhance the value of the

federal lands.

Nearly every study finds that political considerations were important to the Roosevelt

administration. More funds per capita were distributed in areas that were more likely to swing

toward voting for Roosevelt and areas where high voter turnout suggested strong political

interest. The Roosevelt administration appeared to be innovative in its use of radio to reach the

public, and there is evidence that more funds were spent in areas where more families had radios.

Some studies find that the administration might also have been rewarding districts that had long

voted for the Democratic presidential candidate. Since Congress holds the purse strings, the

distribution of New Deal funds was likely influenced by the congressional power structure.

There is some evidence that members of important committees and Congressional leaders were

effective at helping their constituents obtain more New Deal funds (See Fishback, Kantor, and

Wallis 2003; Wallis 1987, 1998, 2001; Wright 1974, Reading 1973, Anderson and Tollison 1991,

Couch and Shughart 1998; Fleck 1994, 1999a, 1999b, 2001; Stromberg 2004).

31

Our political leaders rarely talk about the overall distribution of the federal budget when

promoting their solutions to problems. They instead describe how they develop specific

programs to deal with each issue. Recent studies of specific programs suggest that the

determinants of the geographic patterns are quite different from program to program. The New

Deal seemed to offer something for everybody. The relief programs spent more in areas where

the downturn was more problematic and also appeared to spend more in areas with lower

incomes. Meanwhile, the large-scale farm programs appear to have been largely targeted at

aiding large farms with smaller amounts devoted to helping small farmers and tenants.

Federal loan and mortgage insurance programs, like the RFC, HOLC, and the FHA

programs, tended to be targeted at areas with higher incomes. To obtain loans the recipients had

to have money to help insure repayment. The administration worried that a record of substantial

loan defaults would lead the public to call a halt to existing loan programs and prevent the

creation of future programs.

Even at the program level, there is evidence that political maneuvering played a role in

determining the distribution of funds at the margin. But political success did not mean that the

Roosevelt administration needed to focus strongly on cynically manipulating the elections

through cynically targeting spending on swing states. By operating the relief programs and

spending money where the problems were greatest, the Roosevelt administration could do well in

the upcoming elections by also doing good for those in trouble (See Fishback, Kantor, and Wallis

2003, Mason 2003, Fleck 1999c, Couch, Atkinson, and Wells 1998).

One of the central worries of handing out such large sums around the country was the

potential for corruption. Many of these programs had to be set up from scratch in less than three

months. The CWA was set up in two weeks. The potential for corruption and skimming of funds

was enormous, particularly given the past record of scandals at all level of governments.

Roosevelt knew that for the New Deal to be a success, scandals and corruption had to be

minimized, or else the result would be disaster for his administration. He would bear the blame

32

while bearing little reward from petty corruption. Thus, mechanisms were established to try to

limit corrupt activity. The relief programs, for example, included an investigations division

charged with the task of examining the hundreds of boxes of complaints, investigating them more

thoroughly and then providing support to the Attorney General’s office when prosecution was

warranted. The investigations considered complaints ranging from charges that a local relief

administrator had hired a relief worker for lawn work around her home to charging the Governor

of North Dakota for fraud. Cynics and critics of the New Deal might argue that the division was

investigating everybody except Roosevelt’s administrators. However, the establishment of an

investigative division as part of the basic structure of a program was certainly not common in

state and local government structures at the time. Further, there is evidence that when the federal

government exerted more control of programs, the programs were more likely to follow the

administration’s stated goal. When the federal government exerted more control over how

monies were distributed within states with the move from the FERA to the WPA, the distribution

of funds within states became more targeted at relief, recovery, and reform (Fishback, Kantor and

Wallis 2004).

LONG-TERM LEGACIES OF THE NEW DEAL

By the end of World War II, many of the New Deal agencies—the emergency relief and

public works programs, the RFC, and the NRA—had been shut down. Yet, the New Deal left a

series of lasting legacies, in addition to the farm programs, that remain in place today. Under the

Roosevelt administration’s aegis, workers’ collective bargaining rights were expanded, federal

limits on wages and hours were instituted, financial markets were more strongly regulated, and

the federal government became involved in an extensive public assistance and social insurance

network.

Labor Policy

33

While the NRA’s cartel features were not re-enacted after the agency was eliminated, the

Roosevelt administration sought to maintain the high-wage policies through legislation that

reestablished the rules for union recognition and through the passage of a minimum wage law.

The National Labor Relations (Wagner) Act of 1935 reconstituted the right of workers to

collective bargain through their own representatives from section 7a of the NIRA. Prior to the

1930s public policy toward unionization had focused on the “at will” doctrine. Either the

employer or the worker could terminate the employment relationship. Thus, employers had the

right to refuse to negotiate with union representatives and the right to refuse to recognize a union

even in cases where the vast majority of workers had unionized. Under New Deal legislation

workers had the right to hold elections to seek unionization status. When a majority of workers

voted to accept union representation, the employer was required to recognize the union and enter

into a collective bargaining agreement. In addition, employers could no longer establish

company unions as alternatives to independent organizations. The National Labor Relations

Board (NLRB) was established to oversee union elections and the collective bargaining process.18

The New Deal policies dramatically changed the landscape for unionization and union

organization expanded rapidly during the 1930s. Unions expanded rapidly through a mixture of

union recognition strikes and union elections. In some cases both before and during the 1930s,

when the press for union recognition met staunch resistance from employers, strikes could turn

violent. One of the benefits of the NLRB policies was to regularize the union recognition process

and the incidence of violent strikes has diminished sharply since (Freeman 1998).

The Fair Labor Standards Act (FSLA) of 1938 established the federal government’s role

in setting a national minimum wage, overtime requirements, and child labor restrictions. During

the Progressive Era, proponents of wage and hour limits for male workers had long been

18 The Norris-LaGuardia Act of 1932 had also smoothed the path for union recognition. The act, following acts adopted in several leading Progressive states in the 1910s had limited the use of antitrust laws to treat unions as illegal combinations in restraint of trade, prevented contracts in which workers pledged to not join unions (yellow-dog contracts), and limited the use of injunctions in labor disputes.

34

frustrated by court decisions preventing limits on male labor contracts and by a federal structure

in which states were considered responsible for labor issues. Under the New Deal federal

responses became widespread. After the demise of the NRA, which had been struck down for

delegating too much of Congress’s authority to private groups in setting the codes of competition,

proponents of wage and hours limits turned their attention to Congress. Supreme Court decisions

following the famous attempt by Roosevelt to pack the court gave reformers more confidence that

national labor market policies would survive court scrutiny.

The passage of the FLSA is a classic example of an interest group struggle in which a

significant subset of employers joined with union leaders and reformers to impose limits on other

employers. The proposed minimum wage was expected to raise the wages of low-wage workers,

who tended to be younger, less skilled, black, and located in the South. High-wage employers

who supported the legislation anticipated gains from imposing higher wages on their competitors

who had relied on low wages. They readily joined reformers and unions in calling for the end of

the payment of “substandard” and “oppressive” wages. After the bill was first reported out of

committee in July 1937 it went through a series of revisions before passage in 1938. The

revisions were a series of compromises that made the bill more palatable to interests who had

been on the fence on the issue, including elimination of regional differences in the minimum

wage and limits on the authority of the administrative body. The voting patterns on the various

versions of the bill show that Democrats and legislators from areas with high-wage industries,

more unionization, and more advocates of teenage workers voted for the FLSA. Meanwhile,

those from areas with more retail trade, and low wages tended to vote against. Despite

exemptions for agriculture in the bill, congressman from agricultural areas were more likely to

oppose the bill in anticipation that the exemption might eventually be lifted. Many southern

legislators actively opposed the FLSA because the South was a low-wage region and would be

most affected by the legislation. However, southern congressman were not unanimously

opposed. Hugo Black of Alabama was the Senate sponsor of the bill, while Claude Peppers of

35

Florida and Lister Hill of Alabama were ardent supporters who worked to move the bill out of

committee (Seltzer 1995).

The FLSA imposed a national minimum wage, although agricultural workers, domestic

workers, and employers not involved in interstate commerce were exempted from the act. The

introduction of the minimum wage had its largest effects in the South. Some observers suggest

that it was a key factor that contributed to an increase in Southern wages that helped close the gap

in regional wages (Wright, 1986). An in-depth description of the impact of the minimum wage

on two key southern industries, lumber and seamless hosiery illustrates other immediate effects of

the wage. The most effective way to identify the impact of the minimum wage is to compare the

choices of southern firms, where the minimum wage was binding, with those of northern firms,

where it was not. The seamless hosiery firms followed the classic predictions of economists. At

a time when Northern firms were expanding employment, southern firms reduced employment,

particularly for knitters in low-wage plants, as they shifted toward new mechanized production

processes that reduced the need for low-wage labor. The story in the lumber industry is more

complex but still supports the standard predictions of economists. War-related government

purchases of lumber fueled a large boom in lumber output. As a result, southern lumber firms

actually increased employment after the introduction of the minimum wage, but output from

higher-wage Northern areas rose substantially faster. Southern employment likely would have

rose less or even declined except for two factors. The boom in demand led southern firms to

begin cutting in forests where labor-saving devices were less effective. The majority of southern

lumber firms actively avoided the law by dropping out of interstate commerce to become exempt

from the FLSA, while others illegally paid below the minimum (Seltzer, 1997).

The FLSA is a major legacy of the New Deal. The overtime provisions of time-and-a-

half pay for hours beyond 40 hours for hourly workers have become a major feature of

employment arrangements for hourly workers. These provisions may have contributed to a shift

toward more salaried employment arrangements in the workforce. The minimum wage has been

36

updated through Congressional legislation on several occasions. The original reform bill had

sought to give the administrative body discretionary power over the minimum wage, but a wide

range of interests feared this power would be misused and required the minimum wage to be

updated through legislative amendments. In the presence of nearly continuous inflation, the

established minimum wage becomes less binding each year it remains at the same level.

Currently a relatively small percentage of the workforce is paid the minimum wage and this

group tends to be dominated by teenagers and people who are the second or third wage earners in

their household. 19

Financial Regulations

Roosevelt’s Bank Holiday and the RFC bank loans were temporary methods for solving

problems with bank panics. However, the stock market crash and the vast array of problems in

the banking and construction industries led to pressures for more permanent solutions, including a

wide variety of regulations and the development of new financial institutions that are still with us

today. The Securities and Exchange Commission (SEC) was established to monitor the stock

markets, reporting requirements for firms issuing stock, insider trading, and enforce imposing

rules on market trades.

To stem the tide of future bank runs on deposits, the Roosevelt Administration

established the Federal Deposit Insurance Corporation (FDIC) and the Federal Savings and Loan

Insurance Corporation (FSLIC) to provide federal government insurance of deposits up to a set

limit. Small banks that were not members of the Federal Reserve System played an important

19 Many economists argue that in the low-wage sector the minimum wage involves a tradeoff between higher earnings for those who receive the minimum wage but increased unemployment among low-skilled workers. In the 1990s a debate over the impact of the minimum wage on employment developed. Some empirical studies suggested that the minimum wage did not lead to losses of employment. Much of the discussion of the findings centered on the accuracy of the measures of employment used in the studies. Studies that used total hours of employment tended to find the minimum wage had a negative effect while some studies using rougher measures of numbers of workers tended not to find the negative effect (For example, see Card and Krueger 1995 and Newmark and Waschler 2000).

37

role in promoting the FDIC and heavily influenced its initial rate structure. Banks paid the FDIC

insurance rate on all deposits but protection was given only to the first $5,000 in each account.

This structure meant that larger banks with larger deposits were providing subsidies to the smaller

banks (White 1998, 90-91).

Through the late 1970s, FDIC and FSLIC insurance were considered key contributors to

the absence of bank runs. The demise of savings and loans in the 1980s have led to re-

examination of the history of government deposit insurance and people are more wary of the

institution today. Studies of the state governments’ experiments with deposit insurance in the

early 1900s suggest that the state programs often created more problems than they solved (Alston,

Grove, and Wheelock 1994; Wheelock 1992; White 1983; Calomiris and White 2000, Richardson

and Chung 2003). The main problem was known as moral hazard. Knowing that their deposits

were insured, bankers had incentives to make riskier loans, which in turn increased the likelihood

of bank failures and government bailouts of the banks. For government deposit insurance to

work well, the insurer had to monitor the quality of the banks’ loans and investments and raise

insurance rates for banks that took riskier actions. Alternatively, the government as insurer had to

impose limits on the banks’ actions before providing insurance.20 The FDIC and FSLIC appeared

to be working well to avoid bank failures when financial institutions were tightly regulated

through the late 1970s. However, the savings and loan industry was experiencing declines in

income and net worth that led to potential insolvencies that would have overwhelmed the

FSLIC’s reserves. The savings and loans’ intense lobbying of the FSLIC and Congress

postponed restructuring of the industry. In 1980 and 1982 banks, savings and loans, and other

financial institutions successfully pressed for deregulation that would allow them more latitude in

20 Another problem known as adverse selection also arises in insurance markets. When insurers cannot tell the difference between risky and safe bankers easily, setting of insurance rates can be difficult. Say a state offers deposit insurance at a rate based on the average probability of failure. If bankers are not required to purchase deposit insurance, the state insurance fund was likely to attract primarily bankers facing higher than average risk. Consequently, this adverse selection of bankers would lead to problems with the solvency of the fund. When states began offering deposit insurance, there was a potential problem with riskier bankers being more likely to move into the state.

38

making loans and investments and in the interest payments they could offer depositors.

Meanwhile, the account coverage limit was raised from $40,000 to $100,000 Ultimately, the

combination of aggressive investment strategies by the savings and loans and insufficient

discipline by the FSLIC led to a crisis that shook the industry (White 1998, Kane 1991).

During the 1930s the problems faced by financial institutions were intimately linked with

housing loans. In an attempt to provide liquidity to housing markets and also enhance the quality

of many banks’ loan portfolio, the Home Owners’ Loan Corporation was established. Between

1933 and 1936 the HOLC funds were used to refinance over $3 billion in mortgage loans already

on the verge of foreclosure. In 1934 the Federal Housing Administration was formed to offer

federal insurance for mortgage loans both for new and existing homes and for repair and

reconstruction. In 1938 the Federal National Mortgage Administration (Fannie Mae) began

providing a secondary market for mortgage loans in which banks could sell the loans as assets

and then use the funds to make new mortgages.

Both the HOLC and the FHA carefully vetted the loans that they refinanced and insured

to avoid a large cascade of defaults. As a result, the programs were primarily targeted at people

with higher income or who clearly were faced with only short-term difficulties. The long term

impact of the FHA and Fannie Mae was probably much greater than their short run effects

because they contributed to a permanent of mortgage lending. Prior to the 1930s most mortgage

loans had been five-year loans in which the borrower paid interest during the life of the loan. At

the end of the loan period the borrower repaid the entire principal or sought to roll the loan over

for a new term. Borrowers typically could borrow only up to 50 percent of the value of the

homes. The New Deal housing programs chose loan structures that had been found for only a

small share of loans in the 1920s. The length of the loans was extended to 15-20 years (today

they range up to 30 years) with lower down payment requirements, and amortized repayment

schedules in which the borrower made the same monthly payment over the term of the loan with

no balloon at the end. It is possible that the changes in payment structures contributed to a

39

reduction in defaults associated with the inability to pay balloon payments at the end of the loan,

while the programs may have increased liquidity in housing markets.

The Social Security Act of 1935: Federal Social Insurance and Public Assistance

Roosevelt saw the FERA programs for direct and work relief as temporary and

emergency measures. When the New Deal emergency relief programs were revamped with new

legislation in 1935, the federal government returned responsibility for “unemployables” to state

and local governments and focused instead on using work relief in its emergency programs.

Recognizing that the existing state and local relief meant that there was quite large variation in

opportunities for direct relief and the way it was organized, the administration sought to

reorganize certain forms of state and local relief into a federal system that allowed states to

operate their own programs within federal guidelines and with some funds from the federal

government. The Aid to Dependent Children (ADC), Aid to the Blind (AB), and Old-Age

Assistance (OAA) programs essentially took over the roles played by the state mothers’ pension,

aid to the blind and old-age pension programs. Once all of the states had passed the enabling

legislation to join the system, the new federal/state combination insured that low-income persons

in these categories had nation-wide access to public assistance. However, the program gave

states latitude in setting benefits and some eligibility requirements for aid.

A similar state-by-state flexibility was established for unemployment insurance (UI)

programs. Prior to the Depression UI had met with the least state legislative success of any social

insurance program proposed by the Progressives. Unlike liability for workplace accidents, under

the common law employers had never been liable for aiding their unemployed workers. In the

labor markets at the time several studies have shown that workers in industries where layoffs and

unemployment were a problem generally received higher wages to compensate for this risk.

Several states had rejected bills requiring compulsory unemployment prior to the Depression, but

the number of states considering unemployment compensation rose as unemployment soared.

40

Roosevelt’s campaign promises included unemployment insurance under State laws. By 1934

when the Social Security Act was being developed by the Committee on Economic Security

(CES), only Wisconsin had adopted an unemployment insurance system. Several other states

passed bills in 1935. Although the CES strongly considered a national bill, the long precedent of

state control over labor issues and some fears that a national bill might not survive constitutional

scrutiny led them to choose a federal arrangement. The UI established a basic structure for all

state programs. Employers pay a tax that goes into an unemployment reserve fund for each state

that is managed by the federal government.21 In enabling legislation the states established the

benefits to be paid, the maximum benefit payment, eligibility requirements, and the maximum

duration of unemployment (Baicker, Goldin, and Katz 1998).

One of the central features of U.S. unemployment insurance is experience rating. The

states adopted a wide variety of experience rating systems but the basic principle is the same.

Employers who lay off a higher share of their workers and impose more burdens on the UI

system are expected to pay higher taxes. In comparison with other unemployment systems

around the world, experience rating is unique, but it is designed to solve the same moral hazard

problems that arise under workers’ compensation, deposit insurance, and other forms of

insurance. In some sense, the UI reserve fund is a common pool. In the absence of experience

rating, employers faced with a downturn in their business face extra temptation to lay off workers

rather than to continue paying wages to underutilized workers and losing profits. Even though

they may have to pay higher wage rates to compensate workers for the increased layoffs, by

dumping a disproportionate share of their workers into the UI system, the unemployment taxes of

other employers would subsidize the higher wage rates. Under experience rating the employer

faces additional taxes when he lays off a disproportionate share of workers and thus has less

incentive to dump workers onto UI. In fact, studies of UI that compare the experience rating 21 To ensure that all states would pass the UI, the original legislation called for employers to pay a tax of 3 percent of their payrolls to the federal government. Once the states passed enabling legislation, the bulk of the money would be transferred into a specific state fund managed by the Treasury. States that did not pass the enabling legislation would not receive the tax rebate.

41

systems in different states and that compare northern states with Canada, which has no experience

rating, show that greater experience rating serves to reduce seasonal unemployment fluctuations

(Baicker, Goldin, and Katz 1998).

The basic UI system established under the Social Security Act is largely unchanged since

the New Deal. In comparison with the rest of the world, the U. S. system is unique in that the

states offer a wide variation of benefits, the unemployment taxes are experience rated, and there

are limits on the duration of benefits. Had UI been adopted at a later date, some argue the system

might have been a national one, as a series of Supreme Court decisions and other national policies

have moved away from the long legacy of emphasis on state hegemony over labor markets. But

in some ways our idiosyncratic UI system may have been beneficial in dealing with the shocks to

the global economy. A number of studies suggest that relatively low unemployment benefits,

limited duration of benefits, and experience rating have made unemployment less attractive to

workers in the U.S. and have given our labor markets much more flexibility in responding to

downturns (Blau and Kahn). The state systems may also have given the diverse regions of the

U.S. more flexibility in designing systems that better fit their economies.

The centerpiece of the Social Security Act of 1935 was the establishment of a federal old-

age retirement system. There was a loose precedent for the federal government’s involvement in

old-age retirement pensions. The Civil War disability pension had expanded its eligibility

requirements so broadly that the infirmities of old age were largely covered, so that a substantial

share of the elderly in the North in the early 1900s were receiving federal military pensions. In

1925 a trust fund had been established to pay an average bonus of $1000 to World War I veterans

in 1945. As the Depression worsened, veterans began calling for early payments of the bonus.

Events surrounding a march on Washington in 1932 had culminated in the destruction of a tent

encampment of veterans led by Douglas McArthur. Veterans continued to press for another

payment after Roosevelt was elected, and Congress finally voted a payment over his veto in 1936.

In the meantime pundits like Francis Townsend were calling for substantial old-age pensions that

42

proved popular among the American public, even though the details called for about 40 percent of

GDP to be distributed to the elderly. Huey Long’s press for “Share the Wealth” programs raised

fears that he would siphon votes away from Roosevelt in the 1936 election. These were the

proximate political causes but there was a broad recognition that the share of elderly in the U.S.

population was rising and expected to continue to rise. Since the elderly were more likely to be

infirm and less able to work, the pension program was seen as a means of keeping the elderly off

of public assistance roles.

In seeking to establish an old-age retirement program, the Roosevelt administration could

choose from two options: an insurance model or a social adequacy model. In the insurance

model people would pay premiums into a retirement fund, which would be invested. When

someone retired they would receive benefits based on the accumulated monies in the retirement

fund. The benefits from such a model would have tended to be relatively low given the proposed

premiums to be paid. Some considered the benefits to be inadequate to offset poverty in old age

and instead proposed that the government provide a subsidy to overcome what they considered

society’s failure to provide enough income to adequately provide for old age.

Roosevelt himself demanded the insurance principles when the program was being

considered because he was uncertain of the need for old-age pensions and worried about saddling

future generations with a large debt load. The initial plan tried to split the difference; provide a

subsidy for the elderly as of 1940 who had not had time to accumulate much in the funds and then

make the transition to the insurance plan. By 1939 it became clear that splitting the difference

would not work. The Social Security Act was amended to become a pay-as-you-go plan funded

by taxes on earnings for wage and salary workers and the self-employed.22

Under a pay-go system the government collects taxes from current workers and pays

benefits to the retirees, but there is no explicit contract that ties the taxes paid over the person’s

22See Berkowitz and McQuaid 1992, 123-5, 130-6; Quadagno, 1988, pp. 119-121; Scheiber and Shoven 2000.

43

working lifetime to the benefits that they receive. When the taxes collected exceed the benefits

paid, the government does “invest” the surplus in a trust fund. But the trust fund is composed of

the government’s promises to itself to collect enough taxes to pay benefits to retirees at some

future date.

Neither the tax rates nor benefit rates have been set in stone. In 1940 workers and

employers were each paying one percent of earnings for the old-age program, while the retirees

received benefits equal to roughly one-fourth of the average earnings of those paying taxes.

Since the ratio of retirees to workers was less than one per hundred, the system started in surplus

and the early retirees received payments that far surpassed their contributions to the system. Over

the past 6 decades tax rates and benefits have been restructured several times. Retirement

benefits are now about 40 percent of average earnings for workers. Continued declines in the

number of workers relative to retirees have led social security taxes to rise so that workers and

employers each now pay rates of more than 5 percent. Since the retiree’s share of the population

is expected to continue to rise, we can expect some mixture of social security tax increases, cuts

in benefits, or restructuring of the program over the next few decades (Scheiber and Shoven

2000).

CONCLUSION

In 1933 the U.S. Economy was in the heart of a horrendous Depression. Hoover’s

attempts to offset the economic decline barely retarded the slide into oblivion. Banks had been

failing right and left and there was a new round of panics just around the corner. Claiming that

“We have nothing to fear but Fear Itself,” Roosevelt fearlessly plunged ahead. In the First

Hundred Days of his administration Roosevelt using both hands threw just about every policy his

advisors and Congress could think of at the emergency. You name it and the Roosevelt

Administration tried it: aid for the destitute and the unemployed, public works projects, bank

44

holidays, loans, reorganizations of industry, farm programs. Some programs ran at cross-

purposes with other programs, worsening problems that other programs were assigned to resolve.

There were so many changes and so many programs and so many problems that it is hard

to sort out how successful the New Deal programs were at resolving these issues. It is quite clear

that the U.S. government was a novice at macroeconomic policies, as many fiscal and monetary

policy moves appear inadequate in hindsight. Of course, even today, there is substantial

disagreement among leading economists about how effectively monetary and fiscal policy can

influence real output. So we remain more advanced novices with some conflicting opinions

about the experiences under our belt.

At the operational level many of the programs seemed to have worked reasonably well.

In a short time the Roosevelt administration established government organizations designed to

distribute funds to millions of people and state and local governments. Given the difficulties of

establishing any successful organization, some of the agencies were service operations miracles.

Millions of people directly benefited from work relief and the new federal/state public assistance

programs. Huge numbers of roads, public buildings, and public works were built. Lives were

saved through better public health. Banks stopped failing at a very high rate. The unemployment

rate lurched downward and GNP eventually returned to the peak of 1929, getting set to takeoff

once the economy had pushed past the harsh economic realities of World War II.

Yet a simple relationship of better times with the presence of the programs is not enough

to effectively measure the impact of the policies. When we ask the counterfactual question of

how we would have fared in the absence of the New Deal policies, the answer is more complex.

At no time in American Economic history has the economy failed to rebound and soar to new

heights within a few years, so there is a natural expectation that a rebound would have occurred.

Of course, the administration followed these policies because after four years of sharp decline, no

end to the decline appeared in sight. The situation was so complex with so many things

happening at once, it is hard to sort out the successes and failures. Talented and very intelligent

45

scholars of the New Deal find plenty of room for disagreement about its short run effects. Some

have argued that the sheer volume of policies, changes in direction, and the anticipation that new

policies might be adopted created so much uncertainty that it retarded economic growth (Higgs

1997, Smiley 2002). Nearly every economist considers the cartel-like features of the National

Recovery Administration to have been a misguided experiment that retarded the benefits of

competition in markets. In the farm sector the new policies led to gains for farm owners but may

well have harmed farm workers, tenants, and croppers. Studies that try to control for the fact that

policies were put in place to counteract economic problems in a number of cases find that some

of the New Deal programs made positive contributions, but their impact was not nearly as large

as the surface comparisons suggest.

The New Deal had tremendous long-range consequences for government in the American

economy. The degree to which the role of government was ratcheted up during the peacetime

“crisis” of the 1930s, was a central event that led Robert Higgs (1987) to develop his theories of

the government ratchet effect. Higg’s ratchet effect does not imply no retrenchment of

government activity. Work relief programs, the RFC, the HOLC, the NRA, and other temporary

arrangements were phased out, but so much of the New Deal legacy remains. The ratchet effect

implies that the government after the crisis begins again at a new and higher base. By its end the

New Deal had established a federal network of social insurance and public assistance programs,

federal oversight and insurance of large parts of the financial industry, substantial change in the

rules under which labor markets operated, a whole network of programs in the farm sector, and

many more. We have tinkered with some of these roles. In response to the increasing

sophistication of financial markets and institutions, there was some scaling back of financial

regulation during the late 1970s. Yet, even here there have been few serious challenges to the

idea that the government has some role in regulating these markets. Just the mention of

elimination of social insurance and public assistance programs would be political suicide. The

debates focus instead on better ways to make them work in a context where they have become a

46

growing share of the national economy. Even the farm programs, which are the bane of market-

oriented economists and a world-wide sticking point in international trade negotiations, seem to

have infinite lives. Despite an ever smaller share of people in the farm sector and scandals about

the wealth of those receiving farm subsidies, the politicians who come to office suggesting their

demise often end up expanding the programs.

Only a very small percentage of the American public today participated in the pre-New

Deal economy and even for this group the experience of the Depression forever influenced their

views of the role of government. Given that nearly all of us have lived with the long-term New

Deal institutions all of our lives, it is unlikely that we will eliminate them lightly. Even the many

critics of specific policies recognize that the debate is hardly ever devoted to eliminating the New

Deal programs. The discussion instead focuses on how to make these long-standing programs

work better in our mixed economy.

47

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54

Table 1Major New Deal Programs

Agency or Regulation Enacted Permanent or Temporary

Description

Agricultural Adjustment Administration

1933 permanent Promote higher farm prices through restrictions on output

Civil Works Administration 1933 temporary Grants for work relief jobs on projects that built public works and provided maintenance for public buildings and parks.

Commodity Credit Corporation 1933 permanent Provided loans that guaranteed minimum farm prices.

Fair Labor Standards Act 1938 permanent Established federal minimum wage and work hour restrictions for workers involved in interstate commerce.

Farm Credit Administration 1933 permanent Reorganized and coordinated programs that provided loans to farmers for seed and crops and farm mortgages.

Farm Security Administration 1937 temporary Provided loans and grants to farmers to provide relief and better farming opportunities.

Federal Communications Commission

1934 permanent Regulates interstate communications.

Federal Deposit Insurance Corporation

1933 permanent Provide insurance of bank deposits.

Federal Emergency Relief Administration

1933 temporary Provided grants for relief payments (both direct and work relief) to households with inadequate income.

Federal Farm Mortgage Corporation

1933 permanent Corporation created to issue bonds to help finance farm mortgage and improvement loans.

Federal Housing Administration 1934 permanent Provide Federal Insurance for Home Mortgages

Federal National Mortgage Association

1938 permanent Purchase FHA insured mortgages to provide liquidity in banking markets.

Federal Savings and Loan Insurance Corporation

1934 permanent Federal Insurance of Savings and Loan Deposits

Home Owners Loan Corporation 1933 temporary Provided loan funds to aid banks in refinancing troubled mortgage loans. C10

National Labor Relations Board 1935 permanent Monitors and adjudicates disputes over collective bargaining agreements.

55

National Recovery Administration 1933 temporary Oversaw development of industrial competition codes.

Public Buildings Administration 1932 permanent Provided grants for constructing federal government buildings.

Public Roads Administration 1932 permanent Provided grants for building public highways.

Public Works Administration 1933 temporary Grants and Loans to build large-scale public works.

Public Works Administration Housing Division

1933 temporary Grants and loans for the building of public-housing projects.

Reconstruction Finance Corporation

1932 temporary Provided loans for banks, railroads, industry, local governments. Served as backer for many New Deal programs.

Resettlement Administration 1935 temporary Provided loans and grants to farmers to provide relief and better farming opportunities.

Rural Electrification Administration

1935 permanent Loans to extend electricity service to rural areas and farmers.

Securities and Exchange Commission

1933 permanent Regulate Financial Markets

Social Security Administration Aid to Dependent Children

1935 permanent Federal/state funds to provide aid to children who lost parents.

Social Security Administration Aid to the Blind

1935 permanent Federal/state program to provide aid to the blind.

Social Security Administration Old-Age Assistance

1935 permanent Federal/state program to provide relief funds for elderly indigents.

Social Security Administration Old-Age Pensions

1935 permanent Provides old-age pensions to retired workers.

Tennessee Valley Authority 1933 permanent Large-scale project building dams to create reservoirs and provide electric power.

U.S. Housing Administration 1937 permanent Established loans for public housing projects.

Unemployment Insurance 1935 permanent Established state/federal insurance funds to provide benefits to unemployed workers

Works Progress Administration 1935 temporary Grants for work relief jobs on smaller scale public projects.

Temporary implies that program was ended after the Depression with no transfer of duties to other programs.

56

Figure 1 Federal Budget Deficit, Government Expenditures, and Difference between GNP and 1929 GNP, All in 1958 Dollars

-80.0

-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

1928 1930 1932 1934 1936 1938 1940 1942

Year

1958

Dol

lars

DeficitGNP minus 1929 GNPGexp58

57

FOOTNOTES

58